2025 (7) TMI 440 - AT - Income Tax

Depreciation on goodwill as acquired by the appellant company during the year under consideration on amalgamation - AO held that the intangible assets which were owned/held by the amalgamating company prior to amalgamation at NIL cost has to be taken at NIL cost only in the hands of the amalgamated company. For taxation purposes the value cannot be enhanced and depreciation cannot be allowed. HELD THAT - AO has totally ignored the decision of Hon ble Apex Court/NCLT which categorically approved the scheme of amalgamation/scheme of arrangement at which point the Revenue/AO has not objected the valuation report regarding the difference between the net acquisition of assets and total consideration. The same was recorded as goodwill by the assessee at the said point of time through valuation report. Looking into the decision of Smifs Securities Ltd. 2012 (8) TMI 713 - SUPREME COURT in case of amalgamation if consideration paid by amalgamated company to the amalgamating company is more than the net assets acquired by it then the differential amount shall be treated as goodwill and the amalgamated company shall be eligible for claim of depreciation on such goodwill. Thus CIT(A) has rightly allowed the depreciation on goodwill. Assessee appeal allowed.

Summary

The core legal questions considered in this case revolve around the allowability of depreciation claimed on goodwill arising from an amalgamation, the correct valuation and accounting treatment of goodwill in such a scenario, and the applicability of various provisions of the Income Tax Act, 1961, including sections 32(1), 43(1), 43(6), 49(1)(iii)(e), and 55(2). Additional issues include the treatment of late payment of employee contributions under section 36(1)(va) and the interplay of the scheme of amalgamation approved by the National Company Law Tribunal (NCLT) with income tax provisions.

First, the Tribunal examined whether depreciation on goodwill amounting to Rs. 17,67,63,728/- for AY 2017-18 and Rs. 13,25,72,796/- for AY 2018-19, claimed by the assessee following the amalgamation of Mcfills Enterprises Pvt. Ltd. (transferor) with MR Organosys Pvt. Ltd. (transferee), was allowable under the Income Tax Act. The key question was whether the goodwill created and recorded in the books of the transferee company, which was absent in the transferor company's books before amalgamation, could be depreciated for tax purposes.

Second, the Tribunal considered the legal and factual correctness of the valuation method adopted by the assessee, which claimed to have followed the purchase method under Accounting Standard 14 (AS-14), as opposed to pooling of interests method, and whether the excess consideration over net assets should be credited to capital reserve or goodwill. The issue also involved whether the goodwill was properly recognized as an asset eligible for depreciation or was an accounting artifact inconsistent with tax provisions.

Third, the Tribunal addressed the applicability of specific Income Tax Act provisions governing amalgamation and depreciation, including the interpretation of "actual cost" under Explanation 7 to section 43(1), the sixth proviso to section 32(1), section 49(1)(iii)(e), Explanation 2 to section 43(6), and section 55(2), and whether these provisions precluded depreciation on goodwill created purely by accounting entries during amalgamation.

Fourth, the Tribunal reviewed whether the scheme of amalgamation approved by the NCLT, which included a clause mandating adherence to Income Tax Act provisions and modification of inconsistent terms, had any bearing on the allowability of depreciation on goodwill.

Finally, the Tribunal considered the deletion by the CIT(A) of an addition under section 36(1)(va) relating to late payment of employees' contribution to Provident Fund/ESI and whether this was legally justified.

Regarding the depreciation on goodwill, the Tribunal analyzed the relevant legal framework, including the Income Tax Act provisions and judicial precedents. Section 32(1) permits depreciation on tangible and intangible assets used for business or profession. The provisos and explanations to sections 32 and 43 clarify the treatment of assets in amalgamation scenarios, specifying that the "actual cost" and written down value (WDV) of assets transferred shall be deemed to be the same as in the hands of the amalgamating company. This effectively prevents revaluation or enhancement of asset cost for depreciation purposes post-amalgamation.

The Assessing Officer (AO) disallowed depreciation on goodwill on the ground that the transferor company had no goodwill recorded prior to amalgamation, and the goodwill recorded in the transferee's books was an artificial creation arising from excess consideration paid over net assets. The AO relied on the statutory provisions to assert that the cost of intangible assets transferred in amalgamation must be the same as in the hands of the transferor, which was nil in this case, thus disallowing depreciation on the newly created goodwill. The AO further expressed concerns that the arrangement was a tax avoidance device, citing the absence of business operations by the transferee before amalgamation and the issuance of shares at a huge premium, which inflated the goodwill value artificially.

The assessee countered by emphasizing that the scheme of amalgamation was approved by the NCLT, which included a valuation report prepared by a professional Chartered Accountant valuing the shares and quantifying the goodwill as the difference between total consideration and net assets. The assessee contended that the purchase method under AS-14 was followed, and the goodwill was a legitimate intangible asset arising from amalgamation, eligible for depreciation at 25% as per the Companies Act and applicable accounting standards. The assessee relied heavily on the Supreme Court decision in CIT vs. Smifs Securities Ltd., which held that if consideration paid exceeds the net assets acquired in amalgamation, the excess amount is to be treated as goodwill, and depreciation on such goodwill is allowable.

The Tribunal noted that the AO had disregarded the NCLT-approved scheme and valuation report and had not given due weight to the Apex Court's ruling in Smifs Securities Ltd. The Tribunal observed that the scheme explicitly required adherence to Income Tax Act provisions but did not preclude recognition of goodwill or depreciation thereon where properly valued and approved. The Tribunal also noted that the depreciation claimed was consistent with the purchase method of accounting and AS-14, which the assessee had followed, and that the goodwill was not a mere accounting entry but reflected the commercial reality of excess consideration paid.

Regarding the statutory provisions cited by the AO, the Tribunal held that Explanation 7 to section 43(1) and related provisions do not bar depreciation on goodwill where the goodwill arises from amalgamation and is recognized as an asset in the transferee's books following a proper valuation and scheme approval. The Tribunal emphasized that the Apex Court's decision in Smifs Securities Ltd. is binding and directly applicable, establishing the principle that goodwill arising from excess consideration in amalgamation is a depreciable asset. The Tribunal also distinguished the present case from tax avoidance schemes by noting the approval of the scheme by NCLT and the professional valuation, rejecting the AO's characterization of the transaction as a sham.

On the issue of valuation methodology, the Tribunal accepted the assessee's submission that the purchase method was followed, and the goodwill was properly quantified as the difference between consideration and net assets, in line with accounting standards. The Tribunal rejected the Revenue's argument that pooling of interests method was followed, which would have required crediting the excess to capital reserve rather than goodwill.

Regarding the scheme of amalgamation's clause requiring adherence to Income Tax Act provisions, the Tribunal held that this did not invalidate the recognition of goodwill or depreciation thereon, as the scheme was consistent with tax laws and approved by NCLT. The Tribunal found no inconsistency between the scheme and the Income Tax Act provisions relied upon by the Revenue.

On the deletion of addition under section 36(1)(va) for late payment of employees' contribution, the Tribunal followed the binding precedent of the Supreme Court in Checkmate Services Pvt. Ltd. vs. CIT, which held in favor of the assessee, thereby allowing the deletion.

In conclusion, the Tribunal upheld the CIT(A)'s order allowing depreciation on goodwill arising from amalgamation, dismissing the Revenue's appeal on this issue for both assessment years. The Tribunal also upheld the deletion of the addition under section 36(1)(va). The appeals filed by the Revenue were partly allowed in respect of AY 2017-18 and dismissed for AY 2018-19.

Significant holdings include the following verbatim legal reasoning: "Looking into the decision of Hon'ble Apex Court in case of CIT vs. Smifs Securities Ltd. 348 ITR 302 in case of amalgamation if consideration paid by amalgamated company to the amalgamating company is more than the net assets acquired by it, then the differential amount shall be treated as goodwill and the amalgamated company shall be eligible for claim of depreciation on such goodwill."

The Tribunal established the core principle that goodwill arising from excess consideration paid in an amalgamation, when properly valued and recognized in the books of the transferee company, is a depreciable intangible asset under the Income Tax Act. The Tribunal reaffirmed the binding nature of the Supreme Court's ruling in Smifs Securities Ltd. and emphasized adherence to approved schemes of amalgamation and professional valuations. The Tribunal also clarified that statutory provisions governing amalgamation and depreciation do not preclude depreciation on such goodwill, provided the conditions of valuation and recognition are met.

Final determinations on each issue are as follows: depreciation on goodwill arising from amalgamation is allowable; the valuation method adopted by the assessee is acceptable; statutory provisions cited by the Revenue do not bar depreciation in this case; the scheme of amalgamation approved by NCLT supports the claim; and the deletion of addition under section 36(1)(va) is upheld.